Friday, September 21, 2012

Bridgewater Associates founder Ray Dalio appeared on CNBC this morning for a rare interview. Bridgewater manages $130 billion and is listed as the top hedge fund by net gains since inception. Here's a summary of Dalio's thoughts from this morning as well as the videos:

On QE3 and the US Dollar

Dalio said that QE3 was a good plan. When you ease interest rates, it stimulates private sector credit growth. And then after that you utilize quantitative easing. He feels the US dollar is squeezed due to lots of dollar denominated debt, but after this squeeze he says it's going to decline in the near-term.

On China

The hedge fund titan points out that China can have 6% growth and still think that's depressing all while the US has 2% growth.

He says "it should be part of everyone's
portfolio to some degree because it diversifies the portfolio." He
likens gold to an alternative version of cash and over the long term he
says it's better than cash. "Money can be produced, but gold is
somewhat limited."

On Europe

Bridgewater's founder says there's going to be a "managed depression" in southern Europe in the next few years, and thinks we'll see both a combination of monetary policy (money printing) and a deleveraging and restructuring of debt over there. He says the euro is "likely" to stay together and it is controlled by southern Europeans, though there's more risk for the currency in later years.

On His Biggest Worry

He worries about social distortion and another leg down in various economies causing them. He notes that deleveragings can be painful and we've posted up Dalio's in-depth look at deleveragings before.

On a Possible Downturn in the US Economy

The
Bridgewater founder said that the odds of an unmanaged downturn are
"comparatively low." He likens it to flying on a plane where you could hit an air pocket and that's when problems could arise.

Dalio's Rules of Investing

He says, "I don't get caught up in the moment. I think so many people are reactive and they see things in a very short-term way." He goes on to say that, "almost all important events never happened in your life." He looks at what's happened in the past and uses that as a template for rules for each scenario essentially saying 'if this happens, do that.'

Kyle Bass' Hayman Capital Management this morning filed a 13G on shares of Sealy (ZZ). Per the filing, Hayman has disclosed a 5.9% ownership stake in ZZ with 5,644,245 shares.

This appears to be an increase in Hayman's stake in the company. In their most recent 13F filing detailing portfolio activity as of June 30th, Hayman disclosed ownership of Sealy 8% senior secured third lien convertible notes due July 2016 (ZZC) worth almost $8 million at that time.

Back then, they did not report an equity stake at the time. The filing today was required due to portfolio activity on September 10th.

Per Google Finance, Sealy is "engaged in the consumer products business and manufacture, distribute and sell conventional bedding products, including mattresses and box springs, as well as specialty bedding products, which include latex and visco-elastic mattresses."

Thursday, September 20, 2012

Jim Chanos appeared on CNBC this morning to share his latest thoughts on the market and his positioning. The Kynikos Associates hedge fund founder said that 20% of his global short fund is China. We've posted up the hedge fund China bear thesis before as Chanos notes it's a credit boom over there.

Why He's Short China

He's been quite patient with his China short and it's paid off. He noted that "we get criticized that China's not in smoking ruins ... we've done just fine." Chanos says that corporate profits are imploding in the country.

He points out that while China's exports are important, their imports are also very relevant to watch. While the trade export balance has been decreasing (not a new phenomenon), capital is also leaving and that's a new development Chanos drew attention to.

Lastly, he notes that he wouldn't trust any accounting in China and he could spend an hour talking about that issue alone as corporate accounting is that bad over there.

Chanos' Other Shorts

In regards to what else he's been shorting, he continues to dislike Hewlett Packard (HPQ). He's long Microsoft (MSFT) and Oracle (ORCL) as hedges to that stake.

Chanos again addressed the notion of global value traps (his presentation via that link). He says you want to be short printers and ink. The cloud is fundamentally changing the tech landscape.

On the financial side, he likes to use the term "deleveraging credit python," noting that China, Europe, and the US are the three to watch. In banking, they're long JPMorgan (JPM) and Citi (C). For the other side of the coin, we recently detailed why Bill Ackman sold Citi. Kynikos has also been short Chinese and Spanish banks.

Back in 2007 and 2009, Chanos was short healthcare but he no longer is short. Though he says that longer term, healthcare is a huge issue.

Embedded below are the videos from Chanos' TV appearance this morning. Video 1 on China:

Wednesday, September 19, 2012

This is a classic for all investors. The investor sentiment wheel illustrates the various emotions investors experiences during an investment cycle. Of course, most investors panic at the bottom and sell low and then turn around and buy high.

Tuesday, September 18, 2012

Larry Robbins' hedge fund Glenview Capital just filed an amended 13G with the SEC regarding their position in Tenet Healthcare (THC). Per the filing, Glenview has now disclosed a 12.68% ownership stake in THC with 52,823,831 shares.

This marks a 28% increase in the number of shares they own. Due to the disclosure dates, they've added these shares between July and September. The 13G from today was filed due to trading activity on September 14th.

Why Glenview Likes Tenet

On the heels of the Affordable Care Act (ACA) passing, Tenet was one of Glenview's core holdings. The hedge fund originally started its stake in THC back in March. Their thesis is essentially that for-profit hospitals are entering a "growth on growth" phase due to expanded health insurance coverage.

"Robbins laid out his long thesis for hospitals by pointing out that EBITDA has grown every year for them as they offer 9% CAGR, 1% admission growth, and 2% leverage. He says hospitals benefit from Medicaid eligibility as it reduces bad debt expense ... Robbins points out that it's unlikely that the government could unilaterally take a for profit hospital's profits from reimbursement."

Consensus EPS growth for 2011-13 for THC had been around 28% while Glenview expects 41% from 2011-2014. Glenview also believes that meaningful share repurchase opportunities and/or tuck-in acquisitions are possible.

As of the end of Q2, the hedge fund also owned other companies in the space, including: HCA (HCA), Health Management Associates (HMA), and LifePoint Hospitals (LPNT). That said, THC does seem to be their largest position in the segment and shares recently hit 52-week highs.

Peter Lynch ran Fidelity's Magellan Fund for 13 years and was regarded as one of the most successful investors during his tenure. Lynch outlines the broad gist of his investment philosophy with various pearls of basic wisdom in his book, Beating the Street.

Last week we detailed Lynch on using your edge in investing. This time we wanted to focus on some more of his advice, taken both from "Peter's Principles" and his "Golden Rules of Investing":

Peter's Principles

- "Never invest in any idea you can't illustrate with a crayon"

-"You can't see the future through a rearview mirror"

- "When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6 percent or more, sell your stocks and buy bonds."

- "The best stock to buy may be the one you already own."

Peter Lynch's Golden Rules of Investing

- "You have to know what you own, and why you own it."

- "Never invest in a company without understanding its finances. The biggest losses in stocks come from companies with poor balance sheets. Always look at the balance sheet to see if a company is solvent before you risk your money on it."

- "Everyone has the brainpower to make money in stocks. Not everyone has the stomach. If you are susceptible to selling everything in a panic, you ought to avoid stocks and stock mutual funds altogether."

- "Time is on your side when you own shares of superior companies. You can afford to be patient –even if you are missed Wal- Mart in the first 5 years, it was a great stock to own in the next 5 years. Time is against you when you own options."

Yesterday we posted on commentary from Children Investment Fund's Q2 letter. Today, we're highlighting a write-up from Christopher Cooper-Hohn on one of the fund's newer investments: aerospace equipment provider Safran.

Safran: Sum of the Parts Analysis

"70% of the company’s value is in their civil engine business, which is a 50:50 JV with GE, called CFMI.

The engines that they make power narrow-body aircraft (100-220 passengers). This is an attractive business as competition is limited. If you buy a Boeing 737 you have to buy an engine from CFMI and if you purchase an Airbus A320 you have a choice between CFMI or IAE (a company controlled by Pratt and Whitney).

Once an engine has been sold, Safran benefits from spare parts sales. Margins on engines are very low as they are sold close to cost price, but margins on parts are high (60%+) and engines consume roughly 3x their initial value in parts over their lifetime. This parts business is highly protected as the FAA (and other regulatory bodies) prevent the use of unauthorised parts in engines, so the supply of third party parts is low (about 3% of the total) and will likely decline as leasing companies are against their use (they reduce the resale value of the plane). Another attractive feature of this market is that many of the engine parts (so called LLPs, or Life Limited Parts) have to be changed after a certain number of flights as there are strict rules pertaining to aircraft maintenance.

There is a typical 8-10 years lag between when an engine is sold and when it first requires servicing (it is at service that spares are used). After the first service, engines require regular maintenance for the rest of their 25 year life. Safran have sold 10,300 engines over the last 10 years and of these, only 700 have generated spare parts revenues. The total installed base of engines is approximately 18,000 and fewer than half of these are generating spares revenues for Safran. As the age of the engine fleet matures, spares revenues will increase rapidly.

Although it is easy to see the long term spare parts revenue trend, short term forecasts (3-18 months) are difficult as airlines have some latitude as to what kind of servicing to do. For instance, they can minimally service an engine such that it will fly for another 12 months before coming in again or they can service it so that it will remain on the wing for another 4 years. Airlines can also cannibalise their own spare engines for parts and ground engines which require work rather than servicing them.

As the airline industry has been cash strapped for the last 2 years, spares revenues have not grown since 2009 despite the increasing maturity of the fleet. However, there is a limit as to how much maintenance can be deferred and the pent-up demand for the last two years will have to be addressed at some point.

The future also seems bright. The next generation of narrow-body aircraft is composed of the 737 MAX and the A320neo. The 737 MAX will 100% be powered by CFMI and the A320neo will be powered by CFMI and by Pratt and Whitney. It is important to note though that the engine orders that Safran is booking today will likely be delivered in 2018 and first generate profits for the company in 2028. The strong growth that we expect in profits over the next 12 years is predicated on engine sales which have already happened.

Safran’s valuation is very attractive. The company trades on 9x 2012 EV/EBIT and 13.6x earnings, falling to 11.4x 2013 earnings which is a low absolute valuation compared to peers (aerospace companies typically trade on an average of 15x 2012 earnings) and given the growth in spares revenues.

On a Sum of the parts basis, we value the company at €52 per share with 85% upside. The majority of this value is the engine business (€40 per share) and this values the business at €1.4m per engine which is less than the €2.1m per engine that Pratt and Whitney recently paid Rolls Royce for their stake in IAE (IAE engines are directly comparable to CFMI ones). This difference is probably due to our more conservative assumptions as we discount spares earnings back at 10% pa whereas Pratt and Rolls Royce may have used a lower rate. Using our numbers, there is compelling upside and it is more likely that we are under rather than over-estimating the embedded value of the flying fleet."

Monday, September 17, 2012

Thomas Steyer's hedge fund firm Farallon Capital has just now filed a 13G on shares of Horizon Pharma (HZNP). This is a brand new position for the hedge fund as they did not report ownership back in the second quarter.

Farallon has disclosed a 5.4% ownership stake in the company with 1,883,071 shares. The SEC filing was required due to portfolio activity on September 7th.

Per Google Finance, Horizon Pharma is "a biopharmaceutical company that develops and commercializes medicines to target unmet therapeutic needs in arthritis, pain and inflammatory diseases."

Children's owns QR National where the thesis has been focused on a transition from government-run entity to private company. Management is focused on improving operating performance and achieving growth through investment.

Children's expects the balance sheet to re-leverage over time, anticipating aggressive share buybacks (inclusive of any selling the government might do with its remaining 34% stake). Of the stake, Hohn writes,

They also own a stake in Union Pacific (UNP) and while they see coal headwinds continuing there, they believe the company can grow EPS at 13% for the next several years and generate an IRR of 15%.

On News Corp

Given that News Corp is one of their largest positions and many other hedge funds own it, we wanted to highlight Children's commentary on the name. They're fans of the company's impending split and write:

"At the end of the quarter, the stock is on 11x forward earnings on our numbers and 6.5x EBIT. Low double digit net income growth driven by affiliate fees and re-transmission consent, and supported by the expectation of continued buybacks drives 20%+ net income growth and a 30% midterm IRR without a re-rating. We believe that as the market grows increasingly comfortable with the improved corporate governance at News Corp, the stock can comfortably achieve a 13-14x earnings multiple which 2 years out would point to a $37-40 target price compared to $22 today."

On Walt Disney

Lastly, Children's likes that the Parks segment will see capex programs slow down and think the company will see margin leverage. They write,

"In the near term, margin recovery in the Parks and share buybacks will drive EPS growth up to near 20% for the next few years. We forecast EPS of $3.6 in the upcoming year and $4.2 in the following year. On a 14-15x multiple, this should give a share price trading target of around $60."

Last week we highlighted commentary from market strategist Jeff Saut on performance anxiety that sets in when managers are underperforming their benchmarks. This commentary was timely given that the market has rallied while many hedge funds have had low net exposure.

This time around, Saut logically shifts his focus to identifying market tops. He quotes Justin Mamis on the topic:

"In the end, as the curtain comes down on the bull market you realize that the one rule about tops is not that they provide this or that signal, but that they come before anyone is ready."

Saut also points to further quotation from Mamis that tops are often found when investors are feeling "a comfortableness, a confidence, a conviction that whatever was happening - would continue."

Embedded below is Jeff Saut's commentary on market tops and his thoughts on the current market. He's cautious (but not bearish) about entering new positions and ultimately thinks that the eventual dip will be bought and fuel another rally into year-end:

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